“Boston, MA – In 2014, LPL Financial Research believes portfolios are likely to enjoy more independence from policymakers than in 2013, when the markets and media seemed to obsess over policymakers’ actions both here and abroad. This could be seen throughout 2013 during the government shutdown and debt ceiling debacle, the Federal Reserve’s (Fed) mixed messages on tapering its aggressive bond-buying program, the bank bailout and elections in Europe, and the unprecedented government stimulus referred to as “Abenomics” in Japan, among many other examples.
In the year ahead, there are many reasons investors can return to the basics of growing and preserving their portfolios and spend less time gauging the actions of policymakers, including:
- After two “clean” lifts to the debt ceiling since 2011, which ensured any risk of default on Treasury obligations was avoided, we are unlikely to see concessions in exchange for a third increase in 2014-making a high stakes fiscal battle unlikely.
- The Fed is likely to begin to taper its bond-purchase program, known as quantitative easing (QE), in the first half of 2014, signaling a commitment to reducing its presence in the markets and transitioning to a post-QE environment.
- Europe is emerging from recession, which means less need for direct life support from the European Central Bank or painfully austere fiscal policy as deficit targets are eased.
The economy and markets becoming more independent of policymakers while growth accelerates is likely to bolster investor confidence in the reliability and sustainability of the investing environment.
Key components of LPL Financial Research’s 2014 outlook:
U.S. economic growth may accelerate to about 3% in 2014 after three years of steady, but sluggish, 2% growth. Our above-consensus annual forecast is based upon many of the drags of 2013 fading, including U.S. tax increases and spending cuts and the European recession, and growth accelerating from additional hiring and capital spending by businesses. After all, in the past three years, weakness in government spending subtracted about 0.5% each year from gross domestic product (GDP) growth. Just adding that 0.5% back to GDP in 2014 would, by itself, make a material difference in achieving 3% growth in 2014.
Bond market total returns could likely be flat as yields rise with the 10-year Treasury yield ending the year at 3.25-3.75%. Our view for yields to rise beyond what the futures market has priced in warns of the risk in longer maturity bonds and our preference for shorter-term and credit-oriented sectors of the bond market. High-yield bonds and bank loans are two sectors that have historically proven resilient and often produced gains during periods of rising interest rates. In 2013, both sectors were among the leaders of bond sector performance during a year of higher interest rates. Historically, longer-term bond yields have tended to track the change in GDP growth when unleashed from Federal Reserve actions. Our expectation for a 1% acceleration in U.S. GDP over the pace of 2013 suggests a similar move for the bond market.
Stock market total returns could likely be in the low double digits (10-15%). This gain is derived from earnings per share for S&P 500 companies growing 5-10% and a rise in the price-to-earnings ratio (PE) of about half a point from 16 to 16.5. The PE gain is due to increased confidence in improved growth allowing the ratio to slowly move toward the higher levels that marked the end of every bull market since WWII. As 2014 gets underway, the one-, three-, and five-year trailing annualized returns may all be in the double digits for the first time this business cycle. Our analysis of history shows that it is the five-year return that individual investors tend to chase, based on net inflows to U.S. stock funds. This may prompt many investors to reconsider the role of stocks in their portfolios, especially as interest rates rise and bond performance lags.
In 2014, there may be more all-time highs seen in the stock market and higher yields in the bond market than we have seen in years as economic growth accelerates. The primary risk to our outlook is that better growth in the economy and profits does not develop. That risk is likely to be much more significant than the distractions posed by Fed tapering and mid-term elections. We believe it will be safe in 2014 to again tune out much of the antics in Washington, D.C. as the mid-term elections turn up the volume, but not the impact. In the near term, Washington may be washed up when it comes to driving the markets.”